Ontarians save too little? Maybe not

June 24, 2015

In Ontario's Long Term Report on the Economy, the government references a range of studies, indicating that approximately 20 to 50 percent of households will have insufficient income to maintain a similar standard of living in retirement.

Not only will this place considerable strain on individuals and their families, but also on the Ontario economy, and the province’s finances.[1] The provincial government believes that Ontario has an under-saving problem and cites that as the primary motivation for creating the Ontario Retirement Pension Plan (the ORPP, hereafter). However, the common notion that Ontarians save too little for retirement requires closer examination. The under-saving problem is based on two assumptions[2]:

the household savings rate is insufficient, which has declined from 20 percent in 1980 to 5 percent today; and

the notion that to maintain a pre-retirement lifestyle after retirement, Ontarians need to replace 70 percent of their gross employment income.

The household savings rate is calculated by Statistics Canada as a by-product of Canada’s and the province’s economic accounts. As it is calculated at the aggregate level, it might not be a reliable estimate of each individual Ontarian’s savings for retirement. For example, baby boomers’ rising retirement would keep the household net savings rate artificially low. As baby boomers retire, they use their accumulated savings for current consumption. This inflates consumption numbers. The increase in overall consumption does not mean that the imbalance is all household debt, and therefore a lack of saving. Simply, a large proportion of the population is dissaving for pure consumption. In other word, demographics could be one of the reasons for the currently lower savings rate, but this doesn’t mean future retirees who are currently working are not saving enough for their retirement.

Then, the question becomes how well do Ontarians save for their retirement? Recently, Malcolm Hamilton from the C.D. Howe Institute recalculated the savings rate for Canada and concluded that as the household savings rate headed sharply downward, the amounts contributed to retirement savings plans as a percentage of employment earnings headed sharply upward. Currently, contributions are average 14 percent of earnings and are rising, practically equal to the suggested rate of 13.8 percent required for a comfortable retirement.[3]

Home equity, is also a key component to the finding of a low savings rate. As house prices have risen, more and more Ontarians are allocating an increasing proportion of their disposable income to mortgage repayments. While largely disregarded in current literature, it is highly likely that many Ontarians are using their home equity as a primary source of wealth during retirement and plan to liquidate their house or other real estate properties. This strategy has been fueled by the boom of the housing market and historically low interest rates. Even if this plan is not the case for all Ontarians, the asset value of households’ real estate holdings should not be ignored in assessing seniors’ wealth. Despite this fact, many have criticized that the climbing debt-to-income ratio puts Ontarians “at risk” and should be considered as a sign of overspending. However, the Institute conjectures that the expenditure in settling the mortgage debt is not a consumption spending, but could be considered a form of saving.

Notably, Ontarian’s total net worth (i.e. total assets minus total debt) has increased by 96 percent over the last 13 years. Even for families with middle income earnings, the total net worth has grown by 58 percent. This evidence indicates that Ontarians are in better financial shape than many pessimists have thought. Thus, based on the above evidence, the Institute could not conclude that Ontarians under-save for their retirement.

Further investigation of the under-saving problem in Ontario should be performed by the government before implementing a proposal as significant as the ORPP. The Institute is deeply concerned about the decision of the ORPP, as it adversely affects the goals of another program laid out in the latest budget, the Jobs and Prosperity Fund (JPF). While the JPF aims to incentivize more businesses to locate in Ontario and create high-paying jobs, the ORPP would discourage them by increasing labour costs. As the Institute’s Working Paper 21 showed, Ontario’s unit labour cost (measured as labour compensation divided by productivity) is relatively high in both the manufacturing and non-manufacturing sectors. Ontario’s low productivity combined with relatively high non-wage compensation has been a negative factor for businesses attraction. Adding an additional component to the non-wage compensation package could result in both a substantial cut in disposable income from Ontarians and an increase in businesses’ labour costs. If productivity does not improve, the increase to unit labour cost will further worsen Ontario’s business attractiveness and, consequently, lower the standard living of Ontarians.

[1] The range of studies include: K. Horner, “Retirement Saving by Canadian Households,” (2009) – about 22 percent of households age 30 to 64 are under saving; Mckinsey & Company, “Are Canadians Ready for Retirement?” (2012) – about 19 percent of households are under saving; K. D. Moore, W. Robson and A. Laurin, C.D. Howe Institute, “Canada’s Looming Retirement Challenge,” (2010) – about 35 percent of the 2031 to 2035 retirement cohort are under saving; M. C. Wolfson, “Projecting the Adequacy of Canadians’ Retirement Incomes,” (2011) – about half of mid-level earners born before 1970 are under saving; and CIBC, “Canadians’ Retirement Future: Mind the Gap,” (2013) – about 45 percent of the 1965 to 1969 birth cohort are undersaving; Ministry of Finance, “Ontario’s Long-Term Report on the Economy,” 2014, pp. 149-150.